Weekly Update

Not a “Real” Recession

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Published July 8, 2022

At some point, all the bad news gets priced into stocks. We will see if that has happened in the coming weeks when companies report their quarterly earnings. The bearish market case says that falling corporate earnings are the next shoe to drop. The bullish case points to a myriad of seasonal factors, such as mid-term election market history, to suggest that the worst is behind us in stocks.

(The chart below shows how midterm election years, historically, are typically weak until right before the election, when stocks tend to take flight.)

S&P 500 Index average year-to-date return

The bulls have also been supported as inflation has been dealt some blows with commodity prices dropping back significantly. Rental markets appear to be stabilizing in price, another sign that inflation might be peaking.

Talking about recession is all the rage these days. The National Bureau of Economic Research (NBER) is the official arbiter of recessions. Many economists believe that the technical definition of a recession will be met – e.g. two quarters of falling economic growth. However, many also doubt the NBER will declare that the economy is in a full-blown recession due to the strength of the labor market. It is hard to argue that we are in a recession when unemployment is near record lows. On that topic, we found First Trust’s Brian Wesbury’s recent comments of interest. Here are Brian’s thoughts:

“Real GDP declined at a 1.5% annual rate in the first quarter and, as of Friday, the Atlanta Fed’s “GDP Now” model projects zero growth in Q2. We still think real GDP will turn out to be positive in the second quarter, but if you take the Atlanta GDP Now model at face value, it superficially appears that the odds of having two consecutive quarters of negative growth are close to 50%. That’s important, because two consecutive quarters of negative growth is a rule of thumb that many people use for a recession. We believe a recession is coming but the US is clearly not in one yet. In the first five months of the year, manufacturing production is up at a 6.6% annual rate, nonfarm payrolls are up at an average monthly pace of 488,000, and the unemployment rate has dropped to 3.6% from 3.9%. Meanwhile, in April, both “real” (inflation adjusted) consumer spending and real personal income (excluding transfers) were at record highs. If this is a recession, we could use more recessions. It’s also important to recognize that real gross domestic income (real GDI), an alternative measure of economic output, rose at a 2.1% annual rate in the first quarter. The public pays very little attention to GDI because the government usually takes an additional month to report that data, after GDP is initially released. But, over time, GDI is just as accurate as GDP in describing the performance of the economy. We’re not saying everything is fine with the US economy. Obviously, inflation is taking a huge bite out of people’s earnings. But the debate about whether we’re in a recession should be about real economic pain, not academic-style semantics or whether we fit some technical definition. That’s the reason the official arbiter of recessions, the National Bureau of Economic Research, weighs jobs, manufacturing, and real incomes, when assessing whether we’re in a recession, not just real GDP. We suspect that some of this debate is political, with some champing at the bit to claim there’s a recession because they know it hurts the party of the incumbent president in a mid-term election year. Again, we expect a recession, with a lag, after monetary policy gets tight. And tight it must get in order to wrestle inflation back down toward the Federal Reserve’s 2.0% target. But that means a recession starting in late 2023 or in 2024, not now. Even more unlikely is the notion that the US is on the cutting edge of a recession like the one in 2008-09. Bank capital is well above regulatory requirements and we don’t have a mark-to-market accounting rule that will generate a “fire sale” in bank assets. Nor are we about to have a government lockdown of the private sector, like in 2020. When it comes, the recession will cause economic pain for many. Recessions always do. But we expect something like the recessions in 1990-91 or 2001, when the unemployment rate went up about 2.0 to 2.5 percentage points, not like the soaring unemployment of the Great Recession or the 2020 Lockdown.”


Market Update

A steep drop in oil prices greeted investors upon their return from the July 4th holiday as recession fears rose. Stocks slid over -2% before recovering late in the session to post a +0.2% gain. A similar though more muted move Wednesday saw shares slump then rebound to a +0.4% tally. Investors parsed Fed minutes and the central bank’s ability to fight inflation without tipping the economy too far negative. A rise in jobless claims encouraged investors Thursday leading to a +1.5% gain. Investors are looking for the job market to cool as that will dampen wage growth, one of the major inflationary forces in the economy. The monthly jobs report came Friday, bringing a stronger number than expected. The higher jobs report lessens recessionary fears but heats up inflationary concerns. Investors ultimately took the news as neutral with indexes closing near breakeven.

The S&P 500 (SPY) rose +1.95% this week but remains capped by its 10-week moving average, as it has been since April. The Nasdaq 100 (QQQ) rebounded +4.69%. Smallcap stocks (IWM) added +2.44%.

Warm wishes and until next week.